Introduction to Corporate Finance

Ross et al.: Fundamentals

of Corporate Finance, Sixth

Edition, Alternate Edition

VIII. Topics in Corporate

Finance

26. Leasing © The McGraw−Hill^899
    Companies, 2002

The characteristics of a financial lease, particularly the fact that it is fully amortized,

make it very similar to debt financing, so the name is a sensible one. There are three

types of financial leases that are of particular interest: tax-oriented leases, leveraged

leases,and sale and leaseback agreements.We consider these next.

Tax-Oriented Leases A lease in which the lessor is the owner of the leased asset for

tax purposes is called a tax-oriented lease. Such leases are also called tax leases or true

leases. In contrast, a conditional sales agreement leaseis not a true lease. Here, the

“lessee” is the owner for tax purposes. Conditional sales agreement leases are really just

secured loans. The financial leases we discuss in this chapter are all tax leases.

Tax-oriented leases make the most sense when the lessee is not in a position to use

tax credits or depreciation deductions that come with owning the asset. By arranging for

someone else to hold title, a tax lease passes these benefits on. The lessee can benefit be-

cause the lessor may return a portion of the tax benefits to the lessee in the form of lower

lease costs.

Leveraged Leases Aleveraged leaseis a tax-oriented lease in which the lessor bor-

rows a substantial portion of the purchase price of the leased asset on a nonrecourseba-

sis, meaning that if the lessee defaults on the lease payments, the lessor does not have to

keep making the loan payments. Instead, the lender must proceed against the lessee to

recover its investment. In contrast, with a single-investor lease,if the lessor borrows to

purchase the asset, the lessor remains responsible for the loan payments regardless of

whether or not the lessee makes the lease payments.

Sale and Leaseback Agreements Asale and leasebackoccurs when a company

sells an asset it owns to another party and simultaneously leases it back. In a sale and

leaseback, two things happen:

1. The lessee receives cash from the sale of the asset.


2. The lessee continues to use the asset.
   Often, with a sale and leaseback, the lessee may have the option to repurchase the leased
   asset at the end of the lease.
   An example of a sale and leaseback occurred in August of 2001 when the Malaysian
   government announced that it was setting up a company to buy aircraft owned by
   Malaysian Airlines and lease them back. The goal was to strengthen Malaysian Airlines’
   financial position by providing it with needed cash. In fact, sale and leaseback agree-
   ments often are arranged for this purpose.

ACCOUNTING AND LEASING

Before November 1976, leasing was frequently called off–balance sheet financing.As the

name implies, a firm could arrange to use an asset through a lease and not necessarily

CONCEPT QUESTIONS

26.1a What are the differences between an operating lease and a financial lease?

26.1bWhat is a tax-oriented lease?

26.1c What is a sale and leaseback agreement?

876 PART EIGHT Topics in Corporate Finance

tax-oriented lease
A financial lease in which
the lessor is the owner
for tax purposes. Also
called a true lease or a
tax lease.

leveraged lease
A financial lease in which
the lessor borrows a
substantial fraction of
the cost of the leased
asset on a nonrecourse
basis.

sale and leaseback
A financial lease in which
the lessee sells an asset
to the lessor and then
leases it back.

26.2